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Brattle Economist Optimistic About Role of Wholesale Power Markets in Helping States Implement Energy Policy Goals

In responses to questions posed at today’s Federal Energy Regulatory Commission (FERC) Technical Conference, Brattle Principal Dr. Samuel Newell describes how wholesale power markets and state policies can work together to achieve decarbonization objectives and reliability objectives at a low cost.

“Centralized markets are successfully meeting reliability objectives at lower-than-expected costs, and they have already shown that they can help meet environmental objectives cost effectively when combined with cap-and-trade programs such as SOx and NOx trading, RGGI, or AB32 in California,” Dr. Newell said. “Centralized markets have also shown that they can cost-effectively address the challenges associated with the recent coal plant retirements; however, we need to keep in mind that these markets will not be able to meet objectives they were not designed for, such as new state policy objectives.”

Dr. Newell points out that many states’ decarbonization policies are emerging as a transformative force in the industry, beyond other energy policy goals. Although the full value of reducing carbon emissions to states is not yet reflected in electricity market outcomes (being an environmental externality), market designs can be enhanced to integrate such values. The main challenge is efficiently and fairly accommodating state policy preferences if they differ within single regional markets.

Dr. Newell lists a spectrum of potential approaches to integrate state decarbonization policies into wholesale markets:

The most market-oriented approach to implementing a decarbonization policy is to put a price on carbon emissions. Whether through cap-and-trade, carbon taxes, or ISO-implemented carbon charges, carbon pricing stimulates competition and innovation for reducing emissions most cost effectively. The political acceptability may depend on customer cost impacts, which can be mitigated by returning revenues from carbon-related charges to customers. There are some design advances needed to most effectively implement carbon pricing, such as how to prevent emissions “leakage” to states that do not wish to regulate carbon emissions.

The second most market-oriented approach is deploying broad-based clean energy markets. Renewable energy credit (REC) markets were the early form, but they did not include all forms of non-emitting generation, such as nuclear power. Ideally, clean energy markets allow participation by both new and existing resources of all clean technologies to maximize competition and innovation. Combining clean energy markets with a carbon price can extend the price signal to also distinguish among fossil resources with different emission rates.

Targeted procurements and direct financial support are less market-oriented. Some states are pursuing specific opportunities or addressing immediate problems, such as the retirement of nuclear plants. Targeted actions may be more expedient or politically easier than the other approaches, but their rationale may similarly be to address the current market’s failure to price carbon externalities. Such actions can avoid permanently retiring resources that may be very important and cost-effective in some cases for meeting future decarbonization goals. If such targeted actions are consistent with meeting decarbonization objectives cost effectively, they should be considered a partial correction, not a distortion. Nevertheless, such targeted measures are more likely to be perceived as “picking winners” and eroding investor confidence in the market. In addition, they are less likely than the more market-based approaches to identify the most cost-effective solutions. Therefore, targeted actions are best used only as a temporary approach as states transition to more market-based approaches in the long term.

“We believe that states’ clean energy policies can be integrated into wholesale market designs to harness competition, spur innovation, and guide technology choices to help meet both environmental and reliability objectives cost effectively and remain consistent with a vibrant merchant generation model,” Dr. Newell noted. “This should work even in a future where large amounts of clean energy resources benefit from additional revenue streams that reflect their competitive market value. The prospects for a sustainable and efficient outcome are most promising if states are willing to rely on market-oriented approaches, such as carbon pricing or broad-based competitive markets for clean energy resources.”